Chapter 12 – Establishing a Pay Structure
Chapter Twelve: Establishing a Pay Structure
Welcome to your guide to teaching Chapter Twleve, Establishing a Pay
Structure!
This guide will provide you with a chapter summary, learning
objectives, lecture outlines, solutions to in-chapter case questions and end of chapter
discussion questions and possible responses.
Chapter Twelve Roadmap
We hope you find each chapter of your Instructor Manual practical and useful, but also,
exciting! You can adapt the chapter text, the PowerPoints, and the video to work in an online
class environment, a guided independent study environment, or a face to face or on-ground
environment.
When presenting Chapter Twelve, have the students first read the chapter and
encourage them to absorb the “big picture” of “Establishing a Pay Structure.”
Use the PowerPoint for Chapter Twelve frame your lecture.
Have students read and discuss the cases and their respective questions.
Have students validate their knowledge of the chapter by working through the discussion
questions at the end of the chapter.
Lastly, have students review, journal, or discuss the Key Vocabulary Terms at the end of
the chapter.
ROADMAP: THE LECTURE
ESTABLISHING A PAY STRUCTURE
Chapter Summary
This chapter describes how managers weigh the importance and costs of pay to arrive at a
structure for compensation and levels of pay. The chapter first defines the basic decisions in
terms of pay structure and pay level. Next, it looks at several considerations that influence
these decisions: legal requirements related to pay, economic forces, the nature of the
organization’s jobs, and employees’ judgments about the fairness of pay levels. The chapter
then describes methods for evaluating jobs and market data to arrive at a pay structure. This is
followed by a summary of the alternatives to the usual focus on jobs. The chapter closes with a
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Chapter 12 – Establishing a Pay Structure
look at two issues of current importance – pay for employees on leave to serve in the military
and pay for executives.
Learning Objectives
After studying this chapter, the student should be able to:
1. Identify the kinds of decisions involved in establishing a pay structure.
2. Summarize legal requirements for pay policies.
3. Discuss how economic forces influence decisions about pay.
4. Describe how employees evaluate the fairness of a pay structure.
5. Explain how organizations design pay structures related to jobs.
6. Describe alternatives to job-based pay.
7. Summarize how to ensure that pay is actually in line with the pay structure.
8. Discuss issues related to paying employees serving in the military and paying executives.
I. Introduction
This opening vignette highlights minimum wage is a growing state issue as many states
raise the minimum wage higher than the Federal minimum wage. Challenges arise
when companies work on the boarder and have different minimum wages just across
state lines. Some companies have found that with the higher minimum wage they are
having less turnover, greater job satisfaction, and improved customer service.
Discussion Question and Suggested Response
What are the pros and cons of raising minimum wage?
Answers will vary. Some pros are that employees will have greater job satisfaction, improved
customer service and less turnover. Some cons are the decreased profits, wage compression,
and raising prices to cover increased labor costs.
1. From the employer’s point of view, pay is a powerful tool for meeting the organization’s
goals.
2. Pay has a large impact on the organization such as:
a. Affects employee attitudes and behaviors
b. Influences which kinds of employees are attracted to and retained by the organization
c. Can align employees’ interests with organizational goals
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Chapter 12 – Establishing a Pay Structure
d. Viewed as a sign of status and success
3. Pay is a major cost to organizations. Across all industries, pay averages almost one-
fourth of a company’s revenues.
4. The wholesaling industry spends over 5 percent of revenues on payroll costs. At the
other extreme, transportation, entertainment, and healthcare companies spend more
than 25 percent to 40 percent of revenues on payroll.
5. This chapter describes how managers weigh the importance and costs of pay to arrive at
a structure for compensation and levels of pay for different jobs.
II. Decisions about Pay
1. Job structure consists of the relative pay for different jobs within the organization.
2. Pay level is the average amount, including wages, salaries, and bonuses the
organization pays for a particular job.
3. Together, pay structure and pay levels establish a pay structure that helps the
organization achieve goals related to employee motivation, cost control, and the ability to
attract and retain talented human resources.
4. The organization’s job structure and pay levels are policies of the organization, rather
than the amount a particular employee earns.
5. Establishing a pay structure simplifies the process of making decision about individual
employees’ pay by grouping together employees with similar jobs.
6. Figure 12.1, Issues in Developing a Pay Structure, identifies factors that influence the
development of an organization’s pay structure.
III. Legal Requirements for Pay
1. Pay policies and practices in the United States are subject to government laws and
regulations. For example, just as competing businesses may not conspire to set prices,
they may not conspire to set wage rates.
2. Government regulation affects pay structure in the areas of equal employment
opportunity, minimum wages, pay for overtime, and prevailing wages for federal
contractors.
A. Equal Employment Opportunity
1. Employers may not base differences in pay on an employee’s age, race, or other
protected status. Any differences in pay must be tied to such business-related
considerations as job responsibilities or performance.
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Chapter 12 – Establishing a Pay Structure
2. Job descriptions, job structures, and pay structures can help organizations
demonstrate that they are upholding these laws.
3. A comparable worth policy uses job evaluation to establish the worth of an
organization’s jobs in terms of such criteria as their difficulty and importance to the
organization.
4. Comparable worth policies are controversial. From an economic standpoint, the
obvious drawback is that raising pay for some jobs places the employer at an
economic disadvantage relative to employers that pay the market rate.
B. Minimum Wage
1. In the U.S., employers must pay at least the minimum wage established by law
where a wage is the rate of pay per hour.
2. At the federal level, the 1938 Fair Labor Standards Act (FLSA) establishes a
minimum wage that now stands at $7.25 per hour.
3. From the standpoint of social policy, an issue related to the minimum wage is that it
tends to be lower than the earnings required for a full-time worker to rise above the
poverty level. A number of cities have passed laws requiring a so-called living wage
– essentially a minimum wage based on the cost of living in a particular region.
C. Overtime Pay
1. Another requirement of the FLSA is that employers must pay higher wages for
overtime, defined as hours worked beyond 40 hours per week. The overtime rate
under the FLSA is one and a half times the employee’s usual hourly rate, including
any bonuses and piece-rate payments – amounts paid per item produced.
2. Figure 12.2, Computing Overtime Pay, identifies how overtime is computed.
3. The FLSA requires overtime pay for hours worked beyond 40, whether or not the
employer specifically asked or expected the employee to work those extra hours. If
the employer knows the employee is working overtime but does not pay time and a
half, the employer may be violating the FLSA.
4. Not everyone is eligible for overtime pay. Under the FLSA, executives, professional,
administrative, and outside sales employees are considered exempt employees,
meaning employers need not pay them one and a half times their regular pay for
working more than 40 hours per week. Exempt status depends on the employee’s
job responsibilities, salary level, and “salary basis,” meaning that the employee is
paid a given amount regardless of the number of hours worked or the quality of the
work. The standards can be fairly complicated.
5. Any employee who is not in one of the exempt categories is called a nonexempt
employee. Most workers paid on an hourly basis are nonexempt and therefore
subject to the laws governing overtime pay. However, paying a salary does not
necessarily mean a job is exempt.
D. Child Labor
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Chapter 12 – Establishing a Pay Structure
1. FLSA now sharply restricts the use of child labor, with the aim at protecting
children’s health, safety, and educational opportunities. The restrictions apply to
children younger than 18.
2. Under the FLSA, children aged 16 and 17 may not be employed in hazardous
occupations defined by the Department of Labor, such as mining, meatpacking, and
certain kinds of manufacturing using heavy machinery. Children aged 14 and 15
may work only outside school hours, in jobs defined as nonhazardous and for
limited time periods. A child under age 14 may not be employed in any work
associated with interstate commerce, except work performed in a nonhazardous job
for a business entirely owned by the child’s parent or guardian. A few exemptions
from this ban include acting, baby-sitting, and newspaper delivery.
3. Besides the FLSA, state laws also restrict the use of child labor. Many states
require working papers or work permits for minors and many states restrict the
number of hours or times of day that minors aged 16 and older may work.
E. Prevailing Wages
1. The Davis-Bacon Act of 1931 and the Walsh-Healy Public Contracts Act of 1936 are
two federal laws that govern pay policies of federal contractors. Under these laws,
federal contractors must pay their employees at rates that at least equal the
prevailing wages in the area.
2. The Davis-Bacon Act covers construction contractors that receive more than $2,000
in federal money. The Walsh-Healy Act covers all government contractors receiving
$10,000 or more in federal funds.
IV. Economic Influences on Pay
1. An organization cannot make spending decisions independent of the economy.
2. Decisions about how to respond to the economic forces of product markets and labor
markets limit an organization’s choices about pay structure.
A. Product Markets
1. An organization’s product market includes all the organizations that offer competing
goods and services.
2. An important influence on price is the cost to produce the goods and services for
sale. The cost of labor is a significant part of an organization’s costs.
3. If an organization’s labor costs are higher than those of its competitors, it will be
under pressure to charge more than competitors charge for similar products. In this
way, product markets place an upper limit on the pay an organization will offer. This
upper limit is most important when labor costs are a large part of an organization’s
total costs and when the customer’s place great importance on price.
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Chapter 12 – Establishing a Pay Structure
4. Organizations under pressure to cut labor costs may respond by reducing staff
levels, freezing pay levels, postponing hiring decisions, or requiring employees to
bear more of the cost of benefits such as insurance premiums.
B. Labor Markets
1. Organizations must compete to obtain human resources in labor markets.
2. An organization’s competitors in labor markets typically include companies with
similar products and companies in other industries that hire similar employees.
3. Another influence on labor markets is the cost of living – the cost of a household’s
typical expenses such as house payments, groceries, medical care, and gasoline.
Over time, the cost of living tends to rise. When the cost of living is rising rapidly,
labor markets will demand pay increases. The federal government tracks trends in
the nation’s cost of living with a measure called the Consumer Price Index (CPI).
Did You Know?
Management, Professional, Computer Occupations are the Highest Paid
Looking at broad occupational categories, the highest pay goes to managers, followed by
experts in computers and mathematics. The lowest-paid occupational groups involve agriculture
and services (personal care and food preparation and services.) The pay rates shown in the
graph are for the median worker in each category (half the workers earn more, and half earn
less). However, keep in mind that the range of earnings for an occupational category may be
great. In sales, for example, median earnings range as low as $9.12 for cashiers and as high as
$45.96 for sales engineers. The overall median is low because there are many more cashiers
than sales engineers.
Discussion Question with Possible Response
If a company were to hire a new human resource manager, would the $45.96 figure shown here
for management be an appropriate rate of pay? Why or why not?
It depends on a variety of factors. First, how experienced is the human resource manager? Ho
many years of experience and expertise has the person acquired, and how much industry
knowledge does he or she have? Second, what type of organization is hiring the human
resource manager? A small, brand new company may have much fewer resources upon which
to draw to pay a $90,000 salary whereas a large, established company may have the means to
do so. Other considerations include: is this an existing position? If so, what is the salary range
for that position? It could be the case that this salary is appropriate because that is the level at
which it has been evaluated. Finally, it may be appropriate to pay this high, if the company is
trying to recruit a very talented human resource manager, and wants to provide as attractive and
lucrative of an offer as it possibly can.
C. Pay Level: Deciding What to Pay
1. Although labor and product markets limit organizations’ choices about pay levels,
there is a range within which organizations can make decisions.
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Chapter 12 – Establishing a Pay Structure
2. When organizations have a broad range in which to make decisions about pay, they
can choose to pay at, above, or below the rate set by market forces. Economic
theory holds that the most profitable level, all things being equal, would be at the
market rate.
3. Pay policies are one of the most important human resource tools for encouraging
desired employee behaviors and discouraging undesired behaviors. Therefore,
organizations must evaluate pay as more than a cost, but also as an investment that
can generate returns in attracting, retaining, and motivating a high-quality workforce.
D. Gathering Information about Market Pay
1. To compete for talent, organizations use benchmarking, a procedure in which an
organization compares its own practices against those of successful competitors.
In terms of compensation, benchmarking involves the use of pay surveys.
2. Pay surveys provide information about the going rates of pay at competitors in the
organization’s product and labor markets. The primary collector of this kind of data
in the U.S. is the Bureau of Labor Statistics, which conducts an ongoing National
Compensation Survey measuring wages, salaries, and benefits paid to the nation’s
employees.
3. Human resource professionals need to determine whether to gather data focusing
on particular industries or on job categories. Industry-specific data are especially
relevant for jobs with skills that are specific to the type of product.
V. Employee Judgments about Pay Fairness
1. In developing a pay structure, it is important to keep in mind employee’s opinions about
fairness.
A. Judging Fairness
1. Employees evaluate their pay relative to that of other employees. Social scientists
have studied this kind of comparison and developed equity theory to describe how
people make judgments about fairness.
2. According to equity theory, people measure outcomes such as pay in terms of their
inputs. Figure 12.3, Opinions about Fairness: Pay Equity, provides an example of
how the equity theory works.
3. Employees’ conclusions about equity depend on what they choose as a standard of
comparison.
4. The ways employees respond to their impressions about equity can have a great
impact on the organization. Typically, if employees perceive equity, the employees’
attitudes and behaviors continue unchanged, if they perceive an advantage, they
rethink the situation to see it as merely equitable, and if the employees’ perceive
inequity, they are likely to make up the difference in one of three ways that include put
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Chapter 12 – Establishing a Pay Structure
forth less effort, find ways to increase outcomes, or by withdrawing from the
organization.
B. Communicating Fairness
1. Equity theory tells organizations that employees care about their pay relative to what
others are earning an that these feelings are based on what the employees perceive.
2. Employers must also recognize that employees know much more about what other
employers pay now than they did before the Internet became popular.
3. Managers play the most significant role in communication because they interact with
their employees each day. The HR department should prepare them to explain why
the organization’s pay structure is designed as it is and to judge whether employee
concerns about the structure indicate a need for change.
VI. Job Structure: Relative Value of Jobs
1. Along with market forces and principles of fairness, organizations consider the relative
contribution each job should make to the organization’s overall performance.
2. One typical way of doing this is with a job evaluation – an administrative procedure for
measuring the relative worth of the organization’s jobs.
3. Usually, the organization does job evaluation by assembling and training a committee
consisting of individuals familiar with the jobs to be evaluated.
4. To conduct a job evaluation, the committee identifies each job’s compensable factors,
meaning the characteristics of a job that the organization values and chooses to pay
for.
5. Table 12.1 shows how an organization might value the experience and education of
people performing computer-related jobs
6. Job evaluations provide the basis for decisions about relative internal worth.
7. Organizations may limit its pay surveys to jobs evaluated as key jobs. These are jobs
that have relatively stable content and are common among many organizations, so it is
possible to obtain survey data about what people earn in these jobs.
VII. Pay Structure: Putting It All Together
1. The organization’s pay structure should reflect what the organization knows about
market forces as well as its own unique goals and the relative contribution of each job
to achieving the goals.
2. Organizations typically apply the information by establishing some combination of pay
rates, pay grades, and pay ranges. They may state the pay in terms of a rate per hour,
commonly called an hourly wage, a rate of pay for each unit produced, known as a
piecework rate, or a rate of pay per month, called a salary.
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Chapter 12 – Establishing a Pay Structure
A.Pay Rates
1. If the organization’s main concern is to match what people are earning in
comparable jobs, the organizations can base pay directly on market research into
as many of its key jobs as possible. To do this, the organization looks for survey
data for each job title.
2. Pay policy line is a graphed line showing the mathematical relationship between
job evaluation and pay rate. Figure 12.4, Pay Policy Lines, provides an example
of a pay policy line. By using this line, an analyst can estimate the market pay level
for a given job evaluation.
4. The pay policy line reflects the pay structure in the market, which does not always
match rates in the organization. Survey data may show that people in certain jobs
are actually earning significantly more or less than the amount shown on the pay
policy line.
5. Organizations must weigh all the objectives of their pay structure to arrive at
suitable rates.
Best Practices
Parkland Health Rethinks Entry-Level Pay Rates
Parkland Health and Hospital System has 230 employees earning the lowest wages. They
have been earning more than the Federal minimum wage, but even so they realized they
wanted to pay their employees a more livable wage. They raised the lowest level employee
wages to $10.25 per hour from $8.78 per hour. In doing so, they realized they would also need
to boost the wages of their employees making between $8.78 and $10.25 per hour. The
estimated pay increases could cost Parkland $350,000 in the first year. In order to pay for this
increase, the executives agreed to take the funds from their potential bonus pay. They agreed
to accept smaller bonuses as a way to motivate their entry-level workers. Jim, Dunn, Chief
Talent Officer, said the decision is a way to “break down any gaps or anything between the top
leaders and those who are closest to the patients.”
Discussion Questions with Possible Responses
1. How do you predict these pay rate changes at Parkland Health will affect its
performance?
Since the leaders agreed to the reduction in bonus, most likely they will continue to stay
motivated. The entry-level workers should engage more in their jobs because of the
large pay increase. Most likely customer satisfaction will improve too since the
employees are feel more valued.
2. Do you agree with Jim Dunn’s assertion that these pay decisions were “the right thing to
do”? Why or why not?
Answers will vary
B. Pay Grades
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Chapter 12 – Establishing a Pay Structure
1. Pay grades: sets of jobs having similar worth or content, grouped together to
establish rates of pay.
2. A drawback to pay grades is that grouping jobs will result in rates of pay for
individual jobs that do not precisely match the levels specified by the market and the
organization’s job structure.
C. Pay Ranges
1. Pay structure usually includes a pay range for each job or pay grade. In other
words, the organization establishes a minimum, maximum, and midpoint of pay for
employees holding a particular job within a particular pay grade.
2. A typical approach is to use the market rate or the pay policy line as the midpoint of
a range for the job or pay grade.
3. Pay ranges are most common for white-collar jobs and for jobs that are not covered
by union contracts. Figure 12.5, Sample Pay Grade Structure, shows an example
of pay ranges based on the pay policy line in Figure 12.4.
4. Usually pay ranges overlap somewhat, so that the highest pay in one grade is
somewhat higher than the lowest pay in the next grade.
D.Pay Differentials
1. In some situations, organizations adjust pay to reflect differences in working
conditions or labor markets. These adjustments are called pay differentials.
E. Alternatives to Job-Based Pay
1. The traditional and most widely used approach to developing pay structure focuses
on setting pay for jobs or groups of jobs
2. Delayering refers to reducing the number of levels in the organization’s job
structure.
3. Broader groupings of jobs are often referred to as broad bands. Figure 12.6, IBM’s
New Job Evaluation Approach, provides an example of how this works.
4. Another way organizations have responded to the limitations of job-based pay has
been to move away from the link to jobs and toward pay structures that reward
employees based on their knowledge and skills. Skill-based pay systems are pay
structures that set pay according to the employees’ level of knowledge and what
they are capable of doing.
5. Skill-based pay has disadvantages: (1) it rewards employees for acquiring skills,
but does not provide a way to ensure that employees can use their new skills, (2) if
employees learn skills very quickly, they may reach the maximum pay level so
quickly that it will become difficult to reward them appropriately, (3) it does not
necessarily provide an alternative to the bureaucracy and paperwork of traditional
pay structures because it requires records related to skills, training, and knowledge
acquired, and (4) gathering market data about skill-based pay is difficult because
most wage and salary surveys are job-based.
VIII. Pay Structure and Actual Pay
1. Usually the human resource department is responsible for establishing the
organization’s pay structure.
2. The structure represents the organization’s policy, but what the organization actually
does may be different. As part of its management responsibility, the HR department
therefore should compare actual pay to the pay structure, making sure that policies and
practices match.
3. A common way to do this is to measure a compa-ratio, the ratio of average pay to the
midpoint of the pay range. Figure 12.7, Finding a Compa-Ratio, provides an example
of this.
IX. Current Issues Involving Pay Structure
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Chapter 12 – Establishing a Pay Structure
1. An organization’s policies regarding pay structure greatly influence employees’ and
even the general public’s opinions about the organization.
2. Recent issues related to pay structure include decisions about paying employees on
active military duty and decisions about how much to pay the organization’s top
executives.
A. Pay During Military Duty
1. The Uniformed Services Employment and Reemployment Rights Act (USERRA)
requires employers to make jobs available to their workers when they return after
fulfilling military duties for up to five years.
2. Policies to make up the difference between military and civilian pay are costly. The
employer is paying employees while they are not working for the organization, and it
may have to hire temporary employees as well.
B.Pay for Executives
The media has drawn public attention to the issue of executive pay.
1. A significant form of executive compensation comes in the form of company stock.
2. Figure 12.8, Average CEO Pay at 300 Largest Companies shows percentages of
salary, bonus, stock options, stock, and other forms of pay for CEOs.
3. Another way to think about the equity of CEO pay is to compare it to the pay of other
employees in the organization.
4. An organization’s executives potentially have a much greater effect on the organization’s
performance than other employees have.
5. Top executives set the tone or culture of the organization and employees at all levels are
affected by behavior at the top. As a result, the equity of executive pay can affect more
employees than, say, equity among warehouse workers or sales clerks.
6. Organizations need to plan not only how much to pay managers, but also how to pay
them.
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